Fed Chairman Powell, Reopening the Economy Could Lead to a Temporary Increase in Inflation

  • • Fed Chairman Jerome Powell predicted that as the economy improves, inflation will increase, but that it will only be temporary.
  • • He believes the central bank will be reluctant to lift interest rates unless there is more stable inflation and a return to full employment.
  • • Bond yields rose as Powell spoke, as investors awaited further details on future strategy.

Chairman of the Federal Reserve, Jerome Powell, said on Thursday that while he expects some inflationary pressures in the near future, they are unlikely to be sufficient to prompt the central bank to raise interest rates.

“We expect that as the economy reopens and hopefully picks up, we will see inflation move up through base effects,” Powell gave in a Wall Street Journal meeting. “That could create some upward pressure on prices.”

The market responded negatively to Powell’s remarks, with stocks falling and Treasury yields increasing. Some investors and economists expected him to discuss the recent rate hike, with a potential hint that the Fed’s asset purchase programme could be adjusted.

The Federal Reserve is currently purchasing $120 billion in Treasury and mortgage-backed securities per month. The central bank’s possible implementation of a new version of “Operation Twist,” in which it sells short-term notes and buys longer-dated bonds, has recently sparked market speculation.

Despite expectations from economists and Wall Street strategists, the Federal Reserve is unlikely to intervene in the long end of the yield curve, according to Fed officials, according to CNBC’s Steve Liesman.

Instead, Powell reaffirmed his previous comments on inflation, stating that he does not anticipate the price increase to be long-lasting or sufficient to cause the Fed to abandon its accommodative monetary policy. He did mention that the rising yields, as well as improving economic conditions, had piqued his interest.

“There’s good reason to think that the outlook is becoming more positive at the margins,” he stated.

The Fed prefers inflation to hover about 2%, which it claims indicates a stable economy and allows it to lower interest rates in times of crisis. However, for much of the last decade, the rate has been below that, and inflation has been especially low during the coronavirus pandemic.

Some price pressures are likely to arise as the economy recovers, according to Powell, but they will be transitory and appear higher due to “base effects,” or the gap between last year’s severely depressed levels just as the Covid-19 crisis started.

Raising interest rates, he said, would necessitate the economy returning to full employment and inflation reaching a level that could be sustained above 2%. He doesn’t think any of these things will happen this year.

“There’s just a lot of ground to cover before we get to that,” he said. Even if the economy sees “transitory increases in inflation … I expect that we will be patient.”

The Federal Reserve has stated repeatedly that it will hold short-term rates near zero and maintain its monthly bond-buying programme until it sees not only a low unemployment rate but also a jobs recovery that is “inclusive” across wealth, gender, and racial lines.

Some economists, however, are concerned that the Fed’s commitment to low rates would encourage inflation. Powell said he’s “very aware” of the lessons learned from the 1960s and 1970s’ runaway inflation, but thinks the current situation is unique.

“We’re very mindful and I think it’s a constructive thing for people to point out potential risks. I always want to hear that,” he said. “But I do think it’s more likely that what happens in the next year or so is going to amount to prices moving up but not staying up and certainly not staying up to the point where they would move inflation expectations materially above 2%.”

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